What-is-a-Limited-Liability-Company

What does limited liability mean for a limited company? 

Limited liability relates to how much a company director or shareholder is personally accountable for the debts of their business. Many business owners choose to incorporate as a limited company, rather than working as a self-employed sole trader, mainly because it offers crucial personal financial and legal protection if the company faces issues later on.

 

What is a private limited company?

Companies with limited liability are only accountable for their business debts up to the value of their shares. In the UK, these are referred to as private limited companies. If such a company faces insolvency and goes through a formal liquidation process, like a Creditors’ Voluntary Liquidation (CVL), directors and shareholders may lose their investment in the company. However, they generally won’t be personally responsible or pursued for outstanding debts. There are exceptions, such as debts secured with a personal guarantee or if a director is found guilty of wrongful or fraudulent trading, as explained later in this article.

 

How does limited liability work?

To benefit from limited liability, a company must undergo incorporation at Companies House and be registered as a limited company. The company can take the form of a private limited company, a public limited company, or a limited liability partnership. As long as the company is incorporated, its directors and shareholders will enjoy limited liability. This protection remains whether the company is limited by shares or limited by guarantee; although their structures may differ, limited liability is still conferred.

Once incorporated, the company is considered a distinct legal entity, separate from its directors. This implies that the company bears responsibility for any loans it takes and is the entity sued in case of litigation, rather than its directors.

 

Limited by shares and limited by guarantee: What’s the difference?

A company can adopt either the limited by shares or limited by guarantee structure. Despite differences in how money is withdrawn from the company under these structures, they share a similar principle regarding limited liability. Put simply, in a company limited by shares, shareholders’ liability is confined to the value they paid for their shares. Meanwhile, in a company limited by guarantee, personal liability is restricted to the amount specified in the company’s Memorandum of Association, usually a nominal figure commonly set at £1.

 

Exceptions to limited liability

At times, limited liability may not provide complete protection for a company’s directors or shareholders, and they could be held accountable for their company’s debts.

 I. Fraudulent Trading:

The primary reason limited liability may not safeguard a director is if there is evidence of fraudulent trading or misfeasance. Directors bear specific responsibilities when managing their company, and these responsibilities increase if the company is knowingly insolvent.

Once a director or shareholder becomes aware of their company’s insolvency, they must prioritise the interests of creditors over their own and those of other directors/shareholders. This involves refraining from activities that could worsen creditors’ positions or increase their losses. Directors should avoid acquiring additional loans, selling assets below market value, or augmenting any overdrawn directors’ loans.

Failure to comply with these duties in managing an insolvent company could result in the director being held responsible for some or all of the company’s debts.

II. Personal Guarantees:

To secure funding, directors might be required to provide a personal guarantee, especially for smaller or recently established companies. A personal guarantee serves as security for the lender, indicating that if the company cannot repay the borrowed amount, the director will personally take responsibility for settling the debt.

The need for a personal guarantee arises from the limited liability protection granted to directors upon incorporating their company. Recognising that, due to limited liability, lenders may not recover outstanding debt if a company becomes insolvent and undergoes liquidation, a personal guarantee is sought. This allows lenders to ask the director to repay the remaining amount, thereby increasing their chances of recovering the loan.

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What to do if your limited liability company is in financial difficulty?

Even though your company may grant you limited liability, it does not excuse you from addressing financial issues. On the contrary, as the company’s director, you have a legal obligation to uphold certain standards, especially in safeguarding creditors and protecting their interests.

If your limited liability company faces financial difficulties, it’s crucial to seek advice from a licensed insolvency practitioner promptly. They can guide you through options for rescuing the company, providing the best chance for a successful turnaround while ensuring compliance with your responsibilities as the director of an insolvent company.

For immediate assistance and advice, or to arrange a free no-obligation consultation, contact the experts at Vanguard Insolvency today.

Senior Partner at Vanguard Insolvency Practitioners | Website | + posts

I am an insolvency professional with a distinguished career specialising in commercial insolvency, adeptly navigating Creditors Voluntary Liquidation, Company Voluntary Arrangements, and Company Administrations. With a comprehensive understanding of insolvency laws and an unwavering commitment to ethical practices.